Intro to Finance - Fall 2024 Ch1 PDF

Intro to Finance – Fall 2024 Ch1: Intro to Corporate Finance ZEYAO LUAN RUTGERS BUSINESS SCHOOL Overview 1. Corporate Finance and the Financial Manager 2. Forms of Business Organization 3. The Goal of Financial Management 4. The Agency Problem and Control of the Corporation 5. Financial Markets an...

Intro to Finance – Fall 2024 Ch1: Intro to Corporate Finance ZEYAO LUAN RUTGERS BUSINESS SCHOOL Overview 1. Corporate Finance and the Financial Manager 2. Forms of Business Organization 3. The Goal of Financial Management 4. The Agency Problem and Control of the Corporation 5. Financial Markets and the Corporation Corporate Finance and the Financial Manager What is Corporate Finance? Imagine that you are starting a small business (an ice cream shop), what are some financial decisions that you will be making? The most important questions are What long-term investments should be taken on? Where to get the long-term financing to pay for the investments? How to manage the everyday financial activities (e.g. collecting from customers and paying the suppliers)? The study of ways to answer these questions is, broadly speaking, corporate finance. Corporate Finance and the Financial Manager What is the role of a financial manager? For large corporations, the owners (shareholders) are usually not DIRECTLY involved in making day-to-day business decisions Berkshire Hathaway owns 9.3% of Coco-Cola shares Vanguard owns 10% of Time Warner shares Financial managers as hired to represent owners’ interests and make decisions on their behalf. Corporate Finance and the Financial Manager Financial managers are in charge with three major tasks Capital budgeting Capital structure Working capital management Corporate Finance and the Financial Manager Capital Budgeting Capital Budgeting is the process of planning and managing a firm’s long-term investments Identify investment opportunities that are worth more than they cost to acquire Financial managers consider not only the size of the cash flow, but also the timing and the risk of it Corporate Finance and the Financial Manager Capital Structure Capital Structure is the specific mixture of long-term debt and equity the firm uses to finance its operations How much should the firm borrow? The mixture will affect risk and value of the firm How and where to raise the money? Choose among lenders Chose among loan types Corporate Finance and the Financial Manager Working Capital Management Working capital refers to a firm’s short-term assets (e.g. inventory) and liabilities (money owned to suppliers) How much cash to keep on hand? Does the firm purchase/sell on credit? Working capital management ensures that the firms has sufficient resources to continue its operations and avoid costly interruptions. Corporate Finance and the Financial Manager What category do the following decisions belong to? Deciding how much cash to keep on hand Working capital management Deciding which fixed assets should be purchased Capital budgeting Deciding how many shares to offer in IPO Capital structure Forms of Business Organization Three legal forms of business organization Sole Proprietorship Partnership Corporation Each has its advantages and disadvantages As firms grow, the advantages of the corporate form may outweigh the disadvantages Forms of Business Organization Sole Proprietorship A business owned by one person Simplest and least regulated type The owner keeps all the profit but has unlimited liability for business debts Profit taxed as personal income Limitation: life span, raising equity, new opportunities, difficult to transfer ownership Forms of Business Organization Partnership A business formed by two or more individuals or entities General partnership: all the partners share the profits and all have unlimited liabilities for all partnership debts according to the partnership agreement. Limited partnership: one or more general partners will run the business and have unlimited liability, but there will be one or more limited partners who will not actively participate in the business. Liabilities are limited to the amount of contribution to the partnership. Limitations are similar to sole proprietorship: unlimited liabilities, life span, hard to transfer – inability to raise cash for investment Forms of Business Organization Corporation A business created as a distinct legal entity composed of one or more individuals or entities It is a legal “person” More strictly regulated Advantages: separation of ownership and management Ownership can be steadily transferred Unlimited life Limited liabilities Superior ability to raise cash and grow Disadvantage: double taxation, i.e. capital gain and personal income The Goal of Financial Management What do financial managers want to achieve through their decisions? Two types of goals Profitability Risk The goal of financial management should encompass both factors The Goal of Financial Management The goal of financial management: Maximize current value per share of the existing stocks Maximize the market value of the existing owners’ equity Corporate finance can also be defined as the study of relationship between business decisions and the value of the stock in the business The Agency Problem and Control of the Corporation Agency problem Stockholders own the company, but managers run the company Agency cost The cost of the conflict of interests between the principals (owners) and the agent (managers) Direct Beneficiary expenditure for management Monitoring expense Indirect Lost opportunities The Agency Problem and Control of the Corporation Whether managers act in the best interests of stockholders depend on two important factors Managerial compensation How closely are management goals aligned with stockholders’ goals? Job prospects Control of the firm - Can managers be replaced if they do not pursue stockholders’ goals? Proxy fight (a proxy is the authority to vote someone else’s stock) Takeover Financial Markets and the Corporation Primary advantages of the corporate form of business organization Ownership can be transferred quickly Money can be raised readily These advantages of the corporate form of business are enhanced in the existence of financial markets. Financial Markets and the Corporation Financial Markets and the Corporation Primary and secondary markets Primary market Public offering Private placements Secondary market Ownership transferring Dealer and auction markets Dealer markets / over-the-counter markets Dealers: buy and sell for themselves Auction markets Has a physical location (like Wall Street) The purpose is to match buyers and sellers NYSE and NASDAQ